A heavy bet on real estate

As she watches the Florida real estate market soften around her, Susie Hurst is getting nervous.

The 59-year-old former teacher had thought rental income from several properties she had accumulated over the years would fund her retirement.

But higher insurance costs (the result of hurricanes), taxes and upkeep expenses have turned her cash flow to negative of late. She recently took out a home equity line to cover the shortfall and is considering going back to work. She also is thinking about selling off some of her $1.5 million real estate empire, which consists of a four-unit apartment building, a duplex and a small home adjacent to her own Orlando residence.

The higher costs have reached the point that her net proceeds from the properties this year is projected to amount to just $25,000, while her personal expenses are almost $54,000.

In addition to those factors, a couple of personal ones also are driving her to consider putting up the "for sale" sign. She is in the process of moving to Tennessee to be closer to her children and grandchildren, and she is worried about how much longer she will be able to care for her Florida properties, both for geographic and health reasons.

"In the past, I've done much of the work myself, but am now seeing that I will no longer be able to handle this work by myself," Hurst wrote in a letter requesting a Money Makeover.

Still, like a lot of people heavily invested in real estate in the current downturn, Hurst is concerned about selling now. She fears her profit won't result in a retirement portfolio large enough to sustain a lengthy retirement.

But a team of veteran financial planners crunched the numbers on Hurst's current cash-flow problem and long-range retirement needs and crafted a plan to get her to Tennessee in style.

The plan involves liquidating the real estate portfolio, investing in stocks and bonds, and maximizing her future Social Security payments, said Michael Kitces, director of financial planning for Pinnacle Advisory Group Inc. of Columbia, Md.

"Our objective was to find a way out of a situation that appeared to have no easy answers," said John Hill, Pinnacle's chief executive. "Once we dug in, we found the news is actually very good for Susie."

Hill figures that even if Hurst took a 10 percent price reduction off the value of her properties to account for the market, closing costs and some other expenses, she could generate about $1 million in net proceeds by selling the properties, particularly with some deft tax moves.

She would give up future income from rentals, but the Pinnacle team calculated Hurst's current average return on her real estate assets is 2.4 percent, half of what she could earn in a money market account.

"To some extent, the return on your properties has decreased because the appreciation on them has been so substantial," Kitces said. "Although this has helped you build your net worth, it is no longer very effective in providing income to maintain your standard of living."

Kitces and Hill said Hurst doesn't have to sell everything immediately, however. Start with the small home with a pool on the lot where she lives, because it is unrented now, and then focus on the apartment building, because it generates little positive cash flow, they recommended. That will free up cash flow for the remainder of this year but still leave Hurst with some property.

Owning real estate has been more comfortable for Hurst than dabbling in the stock and bond markets, but that is changing.

"In the past, I had to see it and touch it, but with what happened" with the cost increases and the soft market, "I don't feel that anymore," she said.

And while she doesn't have to race to sell all the units at once, waiting too long could work against her, Hill said.

"We may not be at the bottom" of the real estate cycle, he said. "There could be another decline. There's no guarantee."

The team gave Hurst some guidance on using a popular real estate tax treatment structure, known as a 1031 exchange, if she decides to reinvest in more real estate in Tennessee. But Hurst thinks she instead will invest in a low-fee portfolio of broadly diversified stocks and fixed-income products to build her nest egg for the years ahead.

Meanwhile, Kitces told Hurst to start investigating how much Social Security support she's likely to qualify for as she approaches age 62.

Her current projected benefit of about $550 a month might be substantially less than what she is entitled to because she was married for more than a decade to a spouse who regularly paid maximum benefits into the system, Kitces said.

Finally, the planners strongly urged Hurst to consider buying long-term-care insurance and to update her estate documents, which she said have not been changed in 20 years. Long-term-care insurance would help pay for extended care in a nursing or her own home if she becomes too frail to care for herself.

Implementing the planners' recommendations for her real estate portfolio, Hurst should have enough cash flow to easily fund her retirement, they said.

Running her assets through a Monte Carlo analysis - a computer simulation of thousands of market scenarios - shows Hurst has a 95 percent chance of making it to age 90 (her life expectancy) with at least $100,000 left in her estate, according to the planners.

That assumes a 3.7 percent initial portfolio withdrawal rate, then a decline in the withdrawal rate to 2.8 percent when Social Security kicks in at age 62. Those rates give her enough income to pay her expenses.

Why take Social Security at 62, instead of waiting until her normal retirement age of 66, when her monthly benefit would rise to $730?

Her break-even point, or the age at which waiting or taking benefits early is a wash, is 82. Within those years are a lot of variables, including the health of the Social Security system itself. And having those benefits earlier will provide her with flexibility should the financial markets perform badly early on, the planners said.

The only caveat: If she decides to work after her move to Tennessee, the income could reduce her benefits, they said.

Life will be different for Hurst if she decides to sell.

When she divorced in the 1980s in New York, the couple split their home equity, then worth $75,000 each. After spending time with family in Tennessee, she moved to Florida and caught the real estate bug.

But now she said she is thrilled to hear what the planners have come up with regarding her finances.

"I've been coming to a lot of the same conclusions and have already listed the pool home," she said. "It's wonderful to hear I can get out."